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International trade and investment summary 6
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International trade and investment summary Krugman, P.R., Obstfeld, M. and Melitz, M.J. (2018), International Trade. Theory and Policy, 11th edition Week 6
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CH 10 KrugmanWhen the economies of scale are internal, they not only fragment production internationally,
but by reducing competition and raising profits, they also lead too many firms to enter the
protected industry. With a proliferation of firms in narrow domestic markets, the scale of
production of each firm becomes inefficient.
Standard view:
1. The conventionally measured costs of deviating from free trade are large.
2. There are other benefits from free trade that add to the costs of protectionist policies.
3. Any attempt to pursue sophisticated deviations from free trade will be subverted by
the political process.
The optimum tariff rate is always positive but less than the prohibitive rate (tp) that would
eliminate all imports.
Since an export subsidy worsens the terms of trade, and therefore unambiguously reduces
national welfare, the optimal policy in export sectors must be a negative subsidy, that is, a
tax on exports that raises the price of exports to foreigners. Like the optimum tariff, the
optimum export tax is always positive but less than the prohibitive tax that would eliminate
exports completely.
Theory of the second best = states that a hands-off policy is desirable in any one market
only if all other markets are working properly. If they are not, a government intervention that
appears to distort incentives in one market may actually increase welfare by offsetting the
consequences of market failures elsewhere.
There are two lines of defense for free trade: The first argues that domestic market failures
should be corrected by domestic policies aimed directly at the problems’ sources; the
second argues that economists cannot diagnose market failure well enough to prescribe
policy.
Collective action: While it is in the interests of the group as a whole to press for favorable
policies, it is not in any individual’s interest to do so. The problem of collective action can
best be overcome when a group is small and/or well organized.
Apparel production has two key features. It is labor-intensive and technology is simple.
There are at least two reasons why it is easier to lower tariffs as part of a mutual agreement
than to do so as a unilateral policy. First, a mutual agreement helps mobilize support for
freer trade. Second, negotiated agreements on trade can help governments avoid getting
caught in destructive trade wars.
Binding = when a tariff rate is “bound,” the country imposing the tariff agrees not to raise the
rate in the future.
The lever used to make forward progress is the somewhat stylized process known as a trade
round, in which a large group of countries get together to negotiate a set of tariff reductions
and other measures to liberalize trade.
They can establish a free trade area in which each country’s goods can be shipped to the
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